Short Term Financial Planning

Reference Book: (Fundamental of Corporate Finance by Ross, Westerfield & Jordon (8th Edition))

•What is a reasonable level of cash to keep on hand?

•How much should the firm borrow in short term?
•How much credit should be extended to customers?
Inventory Inventory Cash
Purchased Sold Received
Inventory Period Account Receivable Period

(30 days) (105 days)

Cash Paid
Inventory for Cash
Purchased Inventory Received
Account Payable Period Cash Cycle (105-30) = 75 days

Operating Cycle

• Operating Cycle = Inventory period + A/c Receivable Period

• Operating Cycle = A/c Payable Period + Cash Cycle
• A/c Payable Period + Cash Cycle = Inventory period + A/c
Receivable Period
How to fill this gap between short term inflows and outflows?

•Borrowing
•Holding a liquidity Reserve (Cash or Marketable
Securities)
•Changing the inventory period, receivable period or
payable period
 Item Beginning Ending Average
Inventory 2000 3000 2500
A/c Receivable 1600 2000 1800
A/c Payable 750 1000 875

Net Sales 11500

Cost of goods sold 8200

•Inventory Turnover = Cost of goods sold / Average Inventory = 8200/2500 =3.28

•Inventory Period = 365 days/Inventory Turnover = 365/3.28 = 111.3 days
•Receivable Turnover = Credit Sales / Average Receivables = 11500/1800 = 6.4
•Receivable Period = 365 days / Receivables Turnover = 57 days
•Operating Cycle = Inventory Period + A/c Receivable Period = 111 + 57 = 168
days
•Payable Turnover = Cost of goods sold / Average Payables = 8200/875 = 9.4
•Payable Period = 365 days / Payable Turnover = 365/9.4 = 39 days
•Cash Cycle = Operating Cycle – A/c Payable Period = 168-39 = 129 days
On Average there is a 129 day delay between the time we pay for merchandise
and the time we collect on the sale
 Some Aspects of short term financial Policy
• Size of the firm’s investment in current Assets
• It is measured by level of current assets to sales (Current
Assets / Sales)
• Flexible (Conservative) = High Ratio of Current Assets to Sales
• Restrictive (Aggressive) =Low Ratio of Current Assets to Sales
• The financing of current assets
• It is measured by level of short term debt to long term debt
(Short term Debt / Long term Debt)
• Flexible (Conservative) = Low Ratio of STD to LTD
• Restrictive (Aggressive) =High Ratio of STD to LTD
 Flexible (Conservative) Versus
Restrictive (Aggressive)
Flexible (Conservative) :
• Greater investment in current assets
• Sales may be higher because of liberal credit policies.
• Quick delivery service by maintain high level of
Inventory. Fewer production stoppages
Restrictive (Aggressive) :
• Lower investment in current assets
• Lesser Bad Debts
• More Production stoppages
 Short term borrowing
• Unsecured Loans
• Line of credit
• Compensating Balance
• Letter of Credit
• secured Loans
• Receivable Financing
• Inventory Loans